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Commercial & Business Litigation

The Delaware Corner: Poison Pills and a New Judge

By C. Malcolm Cochran and Jason J. Rawnsley


In Versata Enterprises, Inc. v. Selectica, Inc., ___ A.3d ___, No. 193, 2010 (Del. Oct. 4, 2010), the Delaware Supreme Court upheld a decision of the Court of Chancery blessing the adoption and exercise of a 4.99 percent “poison pill” designed to protect net operating loss (NOL) carryovers.


Trilogy, Inc., a Selectica, Inc. shareholder and competitor whose offers to purchase the company had been rejected, began acquiring Selectica stock knowing that a change of control would reduce the value of Selectica’s NOL carryovers. In response, the Selectica board adopted a shareholder rights plan with a 4.99 percent ownership trigger. It also created a special committee to oversee the operation of the plan. Trilogy intentionally triggered the pill to force Selectica to negotiate a deal that would settle various disputes between the companies and sever their relationship. After financial and accounting advisors assured the Selectica board of the importance of the NOL carryovers to the company and three attempts to negotiate a deal to avert the exercise of the pill were rebuffed, Selectica implemented a share exchange under the rights plan that diluted Trilogy’s percentage of ownership from 6.7 percent to 3.3 percent. The board then adopted a second 4.99 percent shareholder rights plan to ward off future threats.


In reviewing Selectica’s deployment and exercise of its rights plan, the Delaware court applied the test announced in Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985), which first asks whether the board reasonably believed a threat to the corporate enterprise existed and second asks whether its defensive actions were preclusive or coercive and, if not, whether the defensive measures undertaken were “reasonable in relation to the threat.”


Under the first part of the Unocal test, the court held that Selectica had undertaken a reasonable investigation to determine whether the NOL carryovers were an asset worth protecting, making Trilogy’s actions a threat to corporate policy and effectiveness. Specifically, the court focused on the fact that the Selectica board had commissioned a report valuing the company’s NOL carryovers years before the dispute at issue and had solicited advice from accounting and financial experts before adopting the pill. The evidence established that the carryovers were a valuable asset worth protecting, particularly because they made the company more appealing to a potential purchaser. Further, the speed with which the board had adopted the rights plan was found to be reasonable—Trilogy was rapidly increasing its ownership and doing so with the knowledge that a change in control would reduce the value of Selectica’s NOLs.


The court also held that the combination of a rights plan and a classified board was not a preclusive defense under the second part of the Unocal test. Trilogy argued that the 4.99 percent trigger weakened the credibility of a proxy challenger because it diminished the ability to signal financial commitment, making an effective proxy contest realistically unattainable. But the court stated that “the key variable in a proxy contest would be the merit of the bidder’s proposal and not the magnitude of its stockholdings.”


The court also saw no significance in the fact that Selectica had a classified board. While such a board makes it more difficult for an insurgent to gain control, that difficulty alone does not make a successful proxy contest realistically unattainable.


Also under the second part of the Unocal test, Selectica’s defensive measures were found to be collectively reasonable. Trilogy was purchasing stock in order to trigger the pill not because it planned to wage a contest for control of the board, but to bring Selectica to the table to negotiate other disputes between the companies. Selectica’s board had just 10 days to determine whether to carry out a share exchange or a traditional flip-in (which would have diluted Trilogy’s ownership even more) or exempt Trilogy from the operation of the pill (an option made impossible by Trilogy’s refusal to stop acquiring stock). Under the circumstances, the share exchange was found to be a reasonable response to the threat to the company presented by Trilogy’s rapid stock acquisition. The second rights plan was necessary to protect the value of the carryovers beyond the imminent threat.


The court concluded, however, with a warning that its approval of Selectica’s shareholder rights plan should not be understood as an approval of 4.99 percent triggers generally. The poison pill under review was found to be reasonable relative to a specific threat, and the court advised Selectica’s board of directors to be mindful of their fiduciary duties when considering any future tender offers and requests to redeem the pill.


New Judge on the Federal Bench
Also of note in Delaware, a new judge has been appointed to the U.S. District Court for the District of Delaware, filling a position that had been vacant since 2006. Leonard P. Stark, previously a magistrate judge of the court, was formally sworn in on October 15, 2010. Judge Stark, a former Rhodes Scholar, served as an assistant U.S. attorney in Delaware from 2002 to 2007. Though Judge Stark’s appointment brings welcome relief to the court’s busy docket, the court still has a vacant judgeship resulting from the recent retirement of Judge Joseph J. Farnan.


Keywords: litigation, intellectual property, Delaware, poison pill, Unocal, Leonard P. Stark


C. Malcolm Cochran is a director of Richards, Layton & Finger, P.A., in Wilmington, Delaware. Jason J. Rawnsley is an associate in Richards, Layton & Finger's general litigation department.


 
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